AAR CORP’s Management Analysis and Analysis of Financial Position and Results of Operations (in millions of dollars) (Form 10-Q)

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Overview



We report our activities in two reportable segments: Aviation Services comprised
of supply chain and maintenance, repair, and overhaul ("MRO") activities and
Expeditionary Services comprised of manufacturing activities.



The Aviation Services segment consists of aftermarket support and services
offerings that provide spare parts and maintenance support for aircraft operated
by our commercial and government/defense customers. Sales in the Aviation
Services segment are derived from the sale and lease of a wide variety of new,
overhauled and repaired engine and airframe parts and components to the
commercial aviation and government and defense markets. We provide customized
inventory supply chain management, performance-based logistics programs,
customer fleet management and operations, and aircraft component repair
management services. The segment also includes repair, maintenance and overhaul
of aircraft, landing gear and components. Cost of sales consists principally of
the cost of product, direct labor, and overhead.



The Expeditionary Services segment consists of primarily manufacturing
operations with sales derived from the design and manufacture of pallets,
shelters, and containers used to support the U.S. military's requirements for a
mobile and agile force including engineering, design, and system integration
services for specialized command and control systems. Cost of sales consists
principally of the cost of material to manufacture products, direct labor and
overhead.


Our Director of Operational Decision Making (our Managing Director) assesses performance against our segments and uses gross margin as the primary measure of profitability. Gross profit is calculated by subtracting cost of sales from sales. Assets and certain expenses related to corporate activities are not allocated to sectors.

The accounting policies for the segments are the same as those described in Note
1 of Notes to Consolidated Financial Statements included in our Annual Report on
Form 10-K for the fiscal year ended May 31, 2021.



Business Trends and Outlook



Consolidated sales for the second quarter of fiscal 2022 increased $33.0 million
or 8.2% over the prior year quarter primarily due to an increase in sales of
$34.3 million or 8.9% in our Aviation Services segment. Consolidated sales to
commercial customers increased $63.5 million or 32.7% over the prior year
quarter due to the partial recovery in commercial passenger air traffic. Our
consolidated sales to government customers decreased $30.5 million or 14.6%
primarily due to less volume across certain U.S. Government contracts.



Over the long-term, we expect to see strength in our Aviation Services segment
given its offerings of value-added services to both commercial and government
and defense customers. We believe long-term commercial and government growth
trends are favorable. As we continue to experience recovery and growth in our
operations, our long-term strategy continues to emphasize investing in the
business and capitalizing on opportunities in those markets.



Both our commercial and government businesses are subject to the economic
environment, impact of COVID-19, public policy decisions or other factors that
could adversely impact our business, financial condition or results of
operations in the future. A recent example of this was the U.S. Government's
decision to withdraw all U.S. Department of State personnel presence in
Afghanistan. In conjunction with the U.S. exit from Afghanistan, we concluded
our activities in country under our WASS and U.S. Department of Defense
contracts. The operations related to our activities in Afghanistan contributed
revenue of $67 million in fiscal 2021.

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Results of Operations


Three and six month periods ended November 30, 2021

Revenue and gross margin for our two business segments for the three and six months ended November 30, 2021 and 2020 were as follows:




                                              Three Months Ended November 30,           Six Months Ended November 30,
                                              2021           2020        % Change       2021           2020       % Change
Sales:
Aviation Services
Commercial                                 $    257.0     $    192.2         33.7 %  $    524.2     $    361.8        44.9 %
Government and defense                          162.3          192.8       (15.8) %       330.7          386.8      (14.5) %
                                           $    419.3     $    385.0          8.9 %  $    854.9     $    748.6        14.2 %
Expeditionary Services
Commercial                                 $      0.7     $      2.0       (65.0) %  $      0.8     $      7.7      (89.6) %
Government and defense                           16.6           16.6            -          36.0           48.1      (25.2) %
                                           $     17.3     $     18.6        (7.0) %  $     36.8     $     55.8      (34.1) %





                                               Three Months Ended November 30,            Six Months Ended November 30,
                                             2021          2020          % Change         2021           2020       % Change
Gross Profit (Loss):
Aviation Services
Commercial                                 $    44.6     $    37.9             17.7 %  $     75.1     $     54.2        38.6 %
Government and defense                          29.4          28.9              1.7 %        59.8           57.2         4.5 %
                                           $    74.0     $    66.8             10.8 %  $    134.9     $    111.4        21.1 %
Expeditionary Services
Commercial                                 $       -     $     0.1               nm    $        -     $    (1.2)          nm
Government and defense                           4.4           2.6             69.2 %         8.1            7.9         2.5 %
                                           $     4.4     $     2.7             63.0 %  $      8.1     $      6.7        20.9 %

nm – The percentage change is not significant.

Three month period ended November 30, 2021


Aviation Services Segment


Sales in the Aviation Services segment increased $34.3 million or 8.9% over the
prior year period due to a $64.8 million or 33.7% increase in sales to
commercial customers. The increase in sales to commercial customers was
attributable to increased sales of $21.7 million in our MRO activities as
commercial passenger air traffic continues to recover from the impact of
COVID-19.  In addition, sales increased $15.8 million in our aftermarket parts
trading activities which included whole asset sales of $12.0 million during the
second quarter of fiscal 2022 compared to none in the prior year.



During the second quarter of fiscal 2022, sales in this segment to government
and defense customers decreased $30.5 million or 15.8%, from the prior year
period. The prior year quarter included sales of $19.7 million related to the
installation of engines on the C-40 aircraft we are delivering to the Naval Air
Systems Command in support of the U.S. Marine Corps. No engine installation
activities occurred in the second quarter of fiscal 2022.



Changes in estimates and assumptions related to our arrangements accounted for
using the cost-to-cost method are recorded using the cumulative catch-up method
of accounting. In the second quarter of fiscal 2022, we had net favorable
cumulative catch-up adjustments of $5.9 million compared to net favorable
cumulative catch-up adjustments of $2.5 million in prior year quarter.  These
adjustments primarily relate to our long-term, power-by-the-hour programs where
we provide component inventory management and repair services as well as certain
long-term government programs.



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Aviation Services cost of sales increased $ 27.1 million, or 8.5%, compared to the period of the previous year, which corresponds to the increase in sales mentioned above.



Gross profit in the Aviation Services segment increased $7.2 million, or 10.8%,
over the prior year period. Gross profit on sales to commercial customers
increased $6.7 million, or 17.7%, over the prior year period primarily due to
the COVID-19 recovery discussed above. The gross profit margin on sales to
commercial customers decreased to 17.4% from 19.7% in the prior year period,
primarily from the benefit of government workforce subsidies including the
Payroll Support Program in the CARES Act and other subsidies provided by foreign
governments. We recognized a benefit of $2.4 million in cost of sales during the
second quarter of fiscal 2022 related to the government subsidies compared to
$18.1 million in the prior year quarter.



Gross profit on sales to government and defense customers increased $0.5
million, or 1.7%, over the prior year period. Gross profit margin on sales to
government and defense customers increased to 18.1% from 15.0% in the prior year
period, primarily driven by cumulative catch-up adjustments on long-term
government programs.



Shipping Services Segment



Sales in the Expeditionary Services segment decreased $1.3 million, or 7.0%,
from the prior year period primarily due to reduced volume for our mobility
products. Gross profit in the Expeditionary Services segment increased $1.7
million, or 63.0%, over the prior period primarily due to lower raw material
costs. Gross profit margin increased to 25.4% from 14.5% in the prior year
period primarily as a result of these lower raw material costs.



Selling, general and administrative expenses



Selling, general and administrative expenses increased $3.7 million, or 8.5%,
over the prior year period primarily due to the reinstatement of full salary and
benefits which were temporarily reduced during the prior year quarter as part of
our actions to mitigate the financial impact to our business from COVID-19. As a
percent of sales, selling, general and administrative expenses remained
consistent at 10.8% as the reinstatement of compensation was offset by the
favorable impact from our cost reduction actions.



Income Taxes



Our effective income tax rate for continuing operations was 27.5% for the second
quarter of fiscal 2022 compared to 26.5% in the prior year period. The increase
in the effective tax rate in fiscal 2022 is primarily related to higher
non-deductible expenses in fiscal 2022 compared to the prior year.



Discontinued Operations


Loss from discontinued operations was $6.2 million in the prior year period
which was attributable to a $6.0 million increase in our reserve to reflect the
tentative agreement with the U.S. Department of Justice to settle their
investigation of our Contractor-Owned, Contractor-Operated ("COCO") business
under the federal civil False Claims Act.



Six month period ended November 30, 2021


Aviation Services Segment


Sales in the Aviation Services segment increased $106.3 million, or 14.2%, over
the prior year period due to a $162.4 million, or 44.9%, increase in sales to
commercial customers.  The increase in sales to commercial customers was
attributable to increased sales of $53.0 million in our MRO activities as
commercial passenger air traffic continues to recover from the impact of
COVID-19.  In addition, sales increased $46.3 million in our aftermarket parts
trading activities which included whole asset sales of $34.0 million during the
six-month period ended November 30, 2021 compared to $14.0 million in the prior
year period.


During the six-month period ended November 30, 2021, sales in this segment to
government and defense customers decreased $56.1 million, or 14.5%, from the
prior year period.  This decrease was primarily attributable to the timing of
activities for the C-40 aircraft we are delivering to the Naval Air Systems
Command in support of the U.S. Marine Corps.  The prior year period included
sales of $39.5 million related to the installation of engines on the aircraft
while no engine installation activities occurred in fiscal 2022.



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Changes in estimates and assumptions related to our arrangements accounted for
using the cost-to-cost method are recorded using the cumulative catch-up method
of accounting. During the six-month period ended November 30, 2021, we had net
favorable cumulative catch-up adjustments of $4.9 million compared to net
favorable cumulative catch-up adjustments of $2.8 million in prior year period.
These adjustments primarily relate to our long-term, power-by-the-hour programs
where we provide component inventory management and repair services as well as
certain long-term government programs.



Aviation Services cost of sales increased $ 82.8 million, or 13.0%, compared to the period of the previous year, which corresponds to the increase in sales mentioned above.



Gross profit in the Aviation Services segment increased $23.5 million, or 21.1%,
over the prior year period. Gross profit on sales to commercial customers
increased $20.9 million, or 38.6%, over the prior year period primarily due to
the COVID-19 recovery discussed above. In addition, gross profit was unfavorably
impacted in the six-month period ended November 30, 2020 due to asset impairment
charges of $7.0 million and facility consolidation and repositioning costs of
$2.4 million. These items were more than offset by a benefit of $28.2 million in
government workforce subsidies from the Payroll Support Program in the CARES Act
and other subsidies provided by foreign governments. Gross profit margin on
sales to commercial customers decreased to 14.3% from 15.0% in the prior year
period primarily due to the impact of the subsidies in the prior year period
more than offsetting the volume recovery in fiscal 2022.



Gross profit on sales to government and defense customers increased $2.6
million, or 4.5%, over the prior year primarily driven by cumulative catch-up
adjustments on long-term government programs. Gross profit margin on sales to
government and defense customers increased to 18.1% from 14.8% in the prior year
period primarily as a result of these adjustments.



Shipping Services Segment



Sales in the Expeditionary Services segment decreased $19.0 million, or 34.1%,
from the prior year period primarily due to reduced volume for our mobility
products.  Gross profit in the Expeditionary Services segment increased $1.4
million, or 20.9%, over the prior period primarily due to the divestiture of our
composites manufacturing business which was not profitable prior to its
divestiture on August 31, 2020.  Gross profit margin increased to 22.0% from
12.0% in the prior year period primarily as a result of the divestiture.



Selling, general and administrative expenses



Selling, general and administrative expenses increased $7.7 million, or 8.7%,
over the prior year period primarily due to the reinstatement of full salary and
benefits which were temporarily reduced during the prior year period as part of
our actions to mitigate the financial impact of COVID-19. As a percent of sales,
selling, general and administrative expenses decreased to 10.8% from 11.0% in
the prior year period primarily due to the benefit from our actions to reduce
both our fixed and variable cost structure in light of the reduced volumes
from
COVID-19.



Income Taxes



Our effective income tax rate for continuing operations was 26.9% for the
six-month period ended November 30, 2021 compared to 73.7% in the prior year
period. The prior year period included unfavorable stock compensation items
of
$0.9 million.



Discontinued Operations



Income from discontinued operations was $0.3 million in the six-month period
ended November 30, 2021 compared to a loss of $6.8 million in the prior year
period. The loss in the prior year period was attributable to a $6.0 million
increase in our legal reserve discussed above.



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Liquidity, capital resources and financial position



Our operating activities are funded and commitments met through the generation
of cash from operations. In addition to operations, our current capital
resources include an unsecured Revolving Credit Facility and an accounts
receivable financing program. Periodically, we may also raise capital through
common stock and debt financings in the public or private markets. We
continually evaluate various financing arrangements, including the issuance of
common stock or debt, which would allow us to improve our liquidity position and
finance future growth on commercially reasonable terms. Our continuing ability
to borrow from our lenders and issue debt and equity securities to the public
and private markets in the future may be negatively affected by a number of
factors, including the overall health of the credit markets, general economic
conditions, airline industry conditions, geo-political events, and our operating
performance. Our ability to generate cash from operations is influenced
primarily by our operating performance and changes in working capital.



AT November 30, 2021, our liquidity and capital resources included working capital of $ 626.5 million including species of $ 42.7 million.



We maintain a Revolving Credit Facility with various financial institutions, as
lenders, and Bank of America, N.A., as administrative agent for the lenders,
which provides the Company an aggregate revolving credit commitment of $600
million and matures September 25, 2024. Under certain circumstances, we have the
ability to request, but our lenders are not required to grant, an increase to
the revolving credit commitment by an aggregate amount of up to $300 million,
not to exceed $900 million in total.



Borrowings under the Revolving Credit Facility bear interest at the offered
Eurodollar Rate plus 87.5 to 175 basis points based on certain financial
measurements if a Eurodollar Rate loan, or at the offered fluctuating Base Rate
plus 0 to 75 basis points based on certain financial measurements if a Base
Rate
loan.


Borrowings outstanding under the Revolving Credit Facility at November 30, 2021
were $104.5 million and there were approximately $12.1 million of outstanding
letters of credit, which reduced the availability of this facility to $483.4
million. There are no other terms or covenants limiting the availability of
this
facility.



In the first quarter of fiscal 2021, we received $57.2 million from the U.S.
Treasury Department through the Payroll Support Program under the CARES Act.
This funding included a $48.5 million cash grant, which was to be used
exclusively for the continuation of payment of employee wages, salaries and
benefits for employees of certain MRO facilities, and a low interest 10-year
senior unsecured promissory note of $8.7 million. In fiscal 2021, we recognized
the full amount of the grant as contra-expense within Cost of sales and Selling,
general and administrative expenses. The Promissory Note was re-paid in full
during the fourth quarter of fiscal 2021.



As of November 30, 2021, we also had other financing arrangements that did not
limit our availability on the Revolving Credit Facility, including outstanding
letters of credit of $11.6 million and foreign lines of credit of $9.7 million.



On October 18, 2017, we entered into a Credit Agreement with the Canadian
Imperial Bank of Commerce, as lender (the "Credit Agreement"). The Credit
Agreement provided a Canadian $31 million term loan with the proceeds used to
fund the acquisition of two MRO facilities in Canada from Premier Aviation. The
term loan was paid in full at the expiration of the Credit Agreement on November
1, 2021.



We maintain a Purchase Agreement with Citibank N.A. ("Purchaser") for the sale,
from time to time, of certain accounts receivable due from certain customers
(the "Purchase Agreement"). Under the Purchase Agreement, the maximum amount of
receivables sold is limited to $150 million and Purchaser may, but is not
required to, purchase the eligible receivables we offer to sell. The term of the
Purchase Agreement runs through February 22, 2022, however, the Purchase
Agreement may also be terminated earlier under certain circumstances. The term
of the Purchase Agreement shall be automatically extended for annual terms
unless either party provides advance notice that they do not intend to extend
the term.



We have no retained interests in the sold receivables, other than limited
recourse obligations in certain circumstances, and only perform collection and
administrative functions for the Purchaser. We account for these receivable
transfers as sales under ASC 860, Transfers and Servicing, and de-recognize the
sold receivables from our Condensed Consolidated Balance Sheets.



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During the six-month periods ended November 30, 2021 and 2020, we sold $158.4
million and $243.1 million, respectively, of receivables under the Purchase
Agreement and remitted $176.8 million and $268.5 million, respectively, to the
Purchaser on their behalf. As of November 30, 2021 and May 31, 2021, we had
collected cash of $3.7 million and $8.4 million, respectively, which was not yet
remitted to the Purchaser as of those dates and was classified as Restricted
cash on our Condensed Consolidated Balance Sheets.



AT November 30, 2021, we were in compliance with all financial and other covenants under our financing agreements.



On December 16, 2021, our Board of Directors approved a stock repurchase program
in which we may repurchase up to $150 million of our common stock with no
expiration date. The timing and amount of repurchases are subject to prevailing
market conditions and other considerations, including our liquidity and other
investment opportunities. We plan to fully utilize the authorization over
approximately the next two years.



Cash flow from operating activities



Net cash provided by operating activities-continuing operations was $33.4
million in the six-month period ended November 30, 2021 compared to cash
provided of $67.4 million in the prior year period. The decrease from the prior
period of $34.0 million was primarily attributable to a higher reduction in
inventory levels in the prior year period and the proceeds of a $48.5 million
grant from the Payroll Support Program of the CARES Act. These items were
partially offset by a $25 million license fee paid to Unison Industries in the
prior year period for our expanded and extended exclusive distribution
agreement.



Cash flow from investing activities

Net cash used in investing activities was $2.7 million during the six-month
period ended November 30, 2021 compared to a cash provided of $5.6 million in
the prior year period. The decrease over the prior period was primarily related
to proceeds of $10.0 million from the termination of split-dollar life insurance
policies in the prior year period.



Cash flow from financing activities



Net cash used in financing activities was $30.1 million during the six-month
period ended November 30, 2021 compared to cash used of $382.9 million in the
prior year period. The prior year period included the repayment of our
additional draw down on our Revolving Credit Facility. These funds were
originally drawn in late fiscal 2020 as a precautionary measure in light of the
economic and market uncertainty presented by COVID-19.



Critical accounting policies and significant estimates

We make a number of important estimates, assumptions and judgments in the preparation of our financial statements. See management’s discussion of the financial condition and results of operations in our Annual Report on Form 10-K for the year ended. May 31, 2021 for a discussion of our significant accounting policies. There has been no material change in the application of our critical accounting policies during fiscal 2022.


Forward-Looking Statements



This report contains certain forward-looking statements as that term is defined
in the Private Securities Litigation Reform Act of 1995. These forward-looking
statements are based on beliefs of our management, as well as assumptions and
estimates based on information available to us as of the dates such assumptions
and estimates are made, and are subject to certain risks and uncertainties that
could cause actual results to differ materially from historical results or those
anticipated, depending on a variety of factors, including those factors set
forth under Part I, Item 1A in our Annual Report on Form 10-K for the fiscal
year ended May 31, 2021. Should one or more of those risks or uncertainties
materialize adversely, or should underlying assumptions or estimates prove
incorrect, actual results may vary materially from those described. Those events
and uncertainties are difficult or impossible to predict accurately and many are
beyond our control. We assume no obligation to update any forward-looking
statements to reflect events or circumstances after the date of such statements
or to reflect the occurrence of anticipated or unanticipated events.



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